When Edward Levitt observed that the head lease/sublease arrangements in the franchising model permitted a franchisor to “gain some advantage in any possible dispute with the franchisee”, he knew whereof he spoke… This is one of those situations in which both the franchisor and the landlord used the tripartite arrangement to gain an advantage over the franchisee. The landlord surmised that it could act unilaterally to its own benefit with total disregard for the franchisee and the effect that its misleading, inaccurate information and unauthorized actions would likely have on it…

The INFO Franchise Newsletter
March 1, 2003

$400,000 Damage Award Against Country Style

Justice Sandra Chapnik, of Ontario Superior Court has awarded damages of $400,000 to two Toronto owners of a Country Style Doughnut shop.

Country Style failed to act to protect the two shop owners when the landlord of their East York location began construction beside it in 1999. (The franchisees were sub-leasing from Country Style.)

Country Style and the franchisee’s landlord, an Ontario numbered company owned by developer Howard Orfus, are jointly responsible for paying he damages, the judge ruled.

Country Style pans to appeal the judgment according to the company’s lawyer, Arnold Zweig.

“This is almost a U.S.-style award. I’ve never head of this in Canada,” says Les Stewart, head of the Canadian Alliance of Franchise Operators.

The franchisees’ entrance was blocked completely for four to six weeks and, ultimately, the roadway to the restaurant was narrowed, hindering traffic and making he “drive-thru” lane difficult to use.

“The totality of the evidence propels the conclusion that Country Style turned its back on the franchisee when the latter needed it most. For whatever reason, it did not deal with its own franchisee in good faith,” writes Justice Chapnik.

Country Style initially sued the franchisees to collect some $219,000 it said it was owed in rent and other fees. The franchisees filed a counterclaim seeking $1 million in damages against Country Style and the landlord.

Sales at the store, which had been climbing steadily, froze during the nine-month construction period, and then saw a decline, the judge found.

Les Stewart tells INFO that:

“This decision has relevance to all potential and existing franchise litigants. In their June 1998 white paper, the Ministry of Consumer and Business Services stated that there were 5,000 new lawsuits in Ontario started each year.

I believe there are significant implications for franchisors and landlords arising from this decision. Franchising accounts for over 40% and $1 trillion in Canadian annual sales.

To the best of my knowledge, this is the national high-water mark for an award and is the clearest statement of Ontario’s Arthur Wishart Act (Franchise Disclosure), 2000’s “good faith, fair dealings to a commercially reasonable standard” for both parties.

The test of opportunistic behavior in dominant positions is “would the party have acted differently if the ownership of the assets were reversed?”

The Relevant Case Law
Judge Chapnik noted in part:

…”I will briefly summarize some of the main areas of law that are relevant to this case. First, the tort of negligent misrepresentation is an established principle of Canadian tort law. The five general requirements for a successful claim are:

(1) There must be a duty of care based on a “special relationship” between the representor and the representee; (2) the representation in question must be untrue, inaccurate or misleading; (3) the representor must have acted negligently in making the representation; (4) the representee must have relied, in a reasonable manner, on the negligent misrepresentation; and (5) the reliance must have been detrimental to the representee in the sense that damages resulted. See, for example, Queen v. Cognos Inc. [1993] 1 S.C.R. 87 at 88-89…

In the franchising context, the case law imposes a duty of utmost good faith on the franchisor though the relationship between the parties to a franchise agreement is not a fiduciary one. Jirna Ltd. v. Mister Donut of Canada Ltd., [1975] 1 S.C.R. 2. Fleury J. described the nature of the duty in Perfect Portions Holding Co. v. New Futures Ltd. [1995] O.J. No. 2116 (Ont. Gen. Div.) at p. 4.

“A franchise agreement creates a different type of relationship than the usual purchase and sale transaction. In some ways, the franchisee has to continue to rely on the integrity of the franchisor with respect to information privy only to the franchisor. A duty of utmost good faith can be implied in any purchase such as the one described in this case”…

“The vast majority of franchise arrangements involve a commercial lease. Given the desire of many franchisors to control locations and to gain some advantage in any possible dispute with the franchisee, it is customary for franchisors to enter into head leases with landlords and to sublease to their franchisees.”

…The learned arthor proceeds to explain some of the complexities of the tripartite contractual model, particularly when disputes arise between the franchisee and the landlord.

If difficulties arise with the location because of misrepresentations or breaches on the part of the landlord, the franchisees must rely on the franchisor to seek redress because, typically, no contractual relationship exists between the landlord and the franchisee. Where the franchisor, as most often would be the case, co-operates with the franchisee in seeking remedies against the landlord, there is no problem, as the franchisor can pursue the franchisee’s claim against the landlord. Without that co-operation, the franchisee may lack any possible remedy against the landlord. One avenue to explore, depending on the landlord’s level of knowledge about the franchise arrangements, is the possibility that the franchisor, vis-à-vis the landlord, is an agent of the franchisee. This argument may be bolstered by cases…that seem to say that, in the appropriate fact situation, the franchisor is holding the lease as trustee for the franchisee…

Misrepresentation
…Turning to the five requirements for a claim based on negligent misrepresentation, the first issue is whether the franchisee was owed a duty of care by the franchisor and/or the landlord. The relationship of franchisor to franchisee is a complex one. The franchisor’s duty of care, the duty to act in good faith, while not elevated to the status of a fiduciary, speaks to concepts of royalty, respect and fair dealing…

Initially, Country Style and the franchisee articulated a firm resolve against the landlord’s unilateral changes to the site plan. In fact, Country Style wrote to the landlord on July 6, 1999, demanding that all construction and addition to the development be completed according to the site plan. This appears to have influenced the landlord to take certain steps to ameliorate some of the effects of the construction, such as reopening the west entrance to make the roadway passable during construction. But, this occurred at the embryonic stage of the development; and Country Style never followed through on its threats to commence legal action in the event the landlord did not comply with its other reasonable requests…

It appears that somehow the franchisor changed its position in mid-stream and decided to side with the landlord. In my view, in its dealings with the franchisee, Country Style resembled a wolf dressed in sheep’s clothing. Its actions displayed a superficial seductiveness. It says it remained supportive of th franchisee and open to all eventualities. At the same time, it asserts that “it was not incumbent on or the responsibility of Country Style to gather evidence on behalf of the franchisee”. Maybe not, but its actions displayed a perplexing array of contradictory messages. In the end, it failed to support the franchisee and it attempted to walk the fence between the franchisee and the landlord…

In my view, the landlord ought to have foreseen that the franchisee would reasonably rely on its representations contained in the original site plan for the development of the property. A special relationship of proximity existed between the landlord and the franchisee. The landlord must have known that carelessness on its part in the withholding of relevant information might cause damage to the franchisee. I find in the circumstances that the landlord had a duty to the franchisee that obliged it to be accurate regarding the site…

The defendants committed themselves to the Country Style Donut franchise family with energy, loyalty and commitment. Mr. Vukovic, who managed the business on a day-to-day basis, was an exceptionally hard worker. He kept the restaurant open for long hours; he ensured that it was spotless and welcoming. He sat and “schmoozed” with the customers; in the first year of operation, he came to know many of the truckers and the restaurant’s regular customers on a first name basis. In this way, he cultivated a steady clientele. He was, therefore, well positioned to observe first-hand, the effect of the alterations to the site and the franchised business. He reported in detail the sudden stagnation of business, the loss of truckers and the chaos caused by the construction and the new configuration of the plaza. I found his evidence to be consistent and compelling…

Conclusion
When Edward Levitt observed that the head lease/sublease arrangements in the franchising model permitted a franchisor to “gain some advantage in any possible dispute with the franchisee”, he knew whereof he spoke…

This is one of those situations in which both the franchisor and the landlord used the tripartite arrangement to gain an advantage over the franchisee. The landlord surmised that it could act unilaterally to its own benefit with total disregard for the franchisee and the effect that its misleading, inaccurate information and unauthorized actions would likely have on it…

When the ship began to sink, the franchisor left its charge afloat in turbulent waters, without a life jacket. In response to the franchisee’s initial desperation, and with a spasm of energy, Country Style did extend a helping hand, but it failed to pull the floundering swimmer to safety…

Due to its own tenacity, the franchisee managed to survive the flood and reach the shoreline. It was, however, left in a shivering state, vulnerable and uncertain about its future. The resulting divorce has not been a pleasant experience for any of the parties…